Are Bilateral Real Exchange Rates Stationary? Revisiting the Evidence from India

Appreciation or overvaluation of exchange rates in times of capital flows and its impact on exports or even imports is a matter of policy debate. Against such a background, this paper examines empirical evidence of stationarity in the data on India’s bilateral real exchange rates with 16 of its major trading partner countries over a period of 5 decades (from 1960 to 2012). The results from the Lagrange multiplier (LM) unit root test with two structural breaks provide evidence of stationarity only for 9 countries. This is in contrast with the overwhelming evidence of stationarity in earlier studies. The rapid growth of international trade and capital flows particularly prior to the 2008 financial crisis and a concomitant shift in exchange rate regime may have significantly affected the behavior of India’s real exchange rate vis-à-vis some of the countries in our sample. This has implications for the Reserve Bank of India (RBI) to sustain its intervention pace on a continuous basis given the fear of rupee being overvalued. The associated liquidity injection will have important implications for the conduct of India’s monetary policy.